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A Brief Guide to Engineering Financial Calculations: Cash Flow Statement

A business must have access to liquid funds (“cash”) to pay its day-to-day expenses. The statement of cash flow looks at the non-cash accounts to determine the overall flow of cash in and out of a company during a reporting period. 

Key Assumptions

Sources and Uses of Funds:

Sources and Uses of funds are enumerated from two successive Balance Sheets and the Income Statement for the period between them.

  • For Asset accounts, an increase is a use of funds; a decrease is a source of funds.
  • For Liability accounts, an increase is a source of funds; a decrease is a use of funds.
  • For Equity accounts, an increase is a source of funds; a decrease is a use of funds.

On the Statement of Cash Flow, a source of funds is entered as a positive number; and a use of funds is entered as a negative number. This is potentially confusing for asset accounts, where an increase is entered as a negative number.

The short-term credit line (STCL) can be thought of as “negative cash.”

Depreciation is always considered to be a source of funds. So are other non-cash expenses.

Non-Cash Working Capital:

Non-cash working capital is the sum of current assets except cash minus the sum of current liabilities except the short-term credit-line and the current portion of the long-term debt. 

Non-cash working capital 

= (total current assets – cash) 

 – (total current liabilities – STCL  – current portion of long-term debt).

Non-cash working capital is the year-over-year difference in current assets (except cash) and year-over-year difference in current liabilities, with the exception of:  short term debt, and the current portion of long-term debt (which is financing).

Change in non-cash working capital 

= [(\boldsymbol{total\, current\, assets_e} \boldsymbol{cash_e}

     – (\boldsymbol{total\, current\, liabilities_e} \boldsymbol{STCL_e}  \boldsymbol{current\, portion\, of\, long-term\, debt_e})]

–  [(\boldsymbol{total\, current\, assets_s}\boldsymbol{cash_s}

     – (\boldsymbol{total\, current\, liabilities_s}\boldsymbol{STCL_s}  – \boldsymbol{current\, portion\, of\, long-term\, debt_s})]

where the subscript e indicates the value at the end of the reporting period and subscript s indicates the start of the reporting period.

The change in non-cash working capital is also easily tallied from the Statement of Cash Flow. If an asset account has increased during the period, then the change is a use of cash; and so the value of the change in that account would be a negative number. If a liability account has increased over the period, then the change is a source of cash; and so the value of the change in that account is a positive number. 

For a typical Statement of Cash Flow, the change in non-cash working capital is the sum of sources/uses of cash from these six accounts: receivables, inventory, prepaids, accounts payable, accrued expenses, taxes payable.

Cash (including “negative cash”) is excluded here because it’s what we balance everything with later as Net Cash (also called the Funds Flow) during the reporting period, where

Net Cash = Cash – STCL

Calculations 

The Statement of Cash Flow has three sections: Operating Activities, Investing Activities, and Financing Activities. The totals for these activities sum to the change in net cash over the period.

Operating Activities (OA):

  • Enter Net Income for the period from the Income Statement (not retained earnings).
  • Add back in depreciation and any other non-cash charge (as sources of funds). 
  • Add (or subtract if appropriate) the changes in non-cash working capital.
  • Total these entries.

Investing Activities (IA):

  • Enter any additions or removal of asset acquisition costs (if new assets are purchased, then the asset account increases, which is a use of funds, so the value is negative).
  • Enter the gain or loss on sale of shares or investments in other companies (Goodwill and intangibles). (Again, if new assets are purchased, then the value is negative.)
  • Total these entries.

Financing Activities (FA):

  • Enter any new equity injection (an increase in shares would be a source of equity funds) or any withdrawal (a use of equity funds). 
  • Add any new long term borrowing that has occurred (a source of funds) or subtract repayment (a use of funds).
  • Subtract dividends paid (a dividend is a use of equity funds).
  • Total these entries.

Change in Net Cash:

Operating Activities plus Investing Activities plus Financing Activities equals the change in net cash during the period:

Change in Net Cash = OA + IA + FA.

Change in Net Cash is also called the Funds Flow during the reporting period. Funds Flow is the Change in Cash Position from the start of the period to the end of the period, which equals the change in the sum of cash minus the amount of the short-term credit line.

A check can thus be made on the change in Net Cash calculation. Net cash at a point in time is cash minus the amount of the STCL (information found on the balance sheet). The balance sheet at the time when the reporting period starts tells you the net cash as of the start of the period: cash minus the amount of STCL. Similarly, net cash at the end of the period is found from the balance sheet at the time of the end of the period. That means that the Funds Flow (the sum of OA + FA + IA) will equal the change (from the beginning to the end of the period) of the sum of cash minus the amount of the short-term credit line. 

If the change in net cash is negative, the flow of funds is into the company, meaning that sources of cash had be available to the company during the period to support its operations (the cash account going down is a source of cash, just as an increase in the STCL is a source of cash). More cash is being used by the company than it produces. This is not a happy situation if it persists too long.  If the change in net cash is positive, then funds flow is outward. There are uses of cash and/or of the STCL coming out of the company during the period; this means that the company was able to support its activities without having to find more cash from outside. 

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